GCC monetary union: What criteria should we use to determine the location of the common central bank?

The United Arab Emirates (UAE) withdrawn from the planned Gulf monetary union came as a big surprise as it exposed how petty political goal can undermine bigger economic gain. Surely, for the UAE, the ability to house the Gulf central bank in its capital, Abu Dhabi, seems more important than the proper materialization of the Gulf monetary union, a project in the making for almost 30 years.

How reasonable is UAE’s decision to withdraw from the GCC monetary union? What criteria should we use to determine who is a justifiable candidate to host the Gulf central bank? The aim of this column is to shed some light on these critical questions.

On the political front, UAE is perhaps a deserving candidate as it applied to host the Gulf central bank in 2004, much before than Saudi Arabia who applied in 2008. Besides, the plans to diversify government institutions across Gulf countries favor UAE since the GCC Secretariat is already located in Saudi Arabia, while other GCC institutions are located in other GCC countries. The fact that the remaining GCC members (Bahrain, Kuwait, and Qatar) did not show interests in hosting the Gulf central bank, give a political boast to UAE’s proposal of hosting the Gulf central bank in Abu Dhabi.

Besides, there is no clear rule that a common central bank should be located in the most populous or largest economy in the group (i.e. Saudi Arabia). For example, Nigeria is considering joining a monetary union with five other West African countries (The Gambia, Ghana, Guinea, Sierra Leone, and Liberia). Nigeria, by far the most populous country in the group (147 million out of 192 million in the six countries combined) and the largest economy in the group (USD 214 billion of GDP out of USD 238 billion GDP in the six countries combined). Yet, the new West African Central Bank will be located in Accra, the capital of Ghana (with only 22 million people and a GDP of USD 16 billion). By this token, either Bahrain or Qatar seems a plausible candidate to host the Gulf central bank.

On the economic front, the notion that UAE has the right ingredients (e.g. largest financial sector by assets, highly open economy) should be interpreted with caution. Germany was chosen to host the European Central Bank not solely on the basis that it is the largest economy in the Euro area, rather the Bundesbank, Germany’s central bank, had a proven track record of controlling inflation through the second half of the 20th century, and is the most influential member of the European System of Central Banks. This made the German mark one of the most respected currencies, to which many European currencies were pegged before embracing the Euro.

Certainly, none of the central banks in the Gulf region exhibit leadership to succeed as the contender of Gulf central bank. Aside from the day-to-day challenges in implementing meaningful monetary policy, a central bank is also responsible for undertaking serious research work, especially on economic issues. One hardly finds any evidence of systematic scholarly research while browsing GCC central banks’ websites.

Another issue of interest is the availability of economic data that central banks use to evaluate the future path of the economy. The availability of high quality data opens up rich possibilities of doing high quality quantitative research, which has a positive effect in improving the overall research environment. GCC countries differ among themselves in terms of economic data coverage. UAE is infamous for its poor data quality of consumer prices and national income aggregates, while public availability of Qatar’s balance of payment data is virtually nonexistent. In this regard, both the Kuwait and Saudi Arabia stand out as the best barometers of the quality of data published within the GCC region, although more work is needed to further improve the data coverage.

Clearly, the criteria to host a common central bank should be dealt more objectively. Lacking monetary policy independence due to the exchange rate peg, the GCC central banks could be evaluated on the basis of maintaining discipline in the domestic financial sector, adequacy of data dissemination, and especially research output—when deciding on the location of the Gulf central bank. Bahrain is probably as financially advanced as the UAE is, Kuwait has a developed futures market, while Qatar is rapidly promoting its financial center; thus UAE has to offer something extra in support of hosting the Gulf central bank. Certainly investing in economic research is one area that would make UAE stand out amongst the others.

The UAE’s pull out announcement is likely to weaken the proposed currency union. Nevertheless, the present crisis also offers a new chance to collectively work on fulfilling several preconditions for the union including coordination of payment systems, improvement in data gathering and sharing, harmonization of legal codes, among many others. As such, UAE’s decision doesn’t affect its broader membership in the GCC, such as the Gulf Common Market which was launched in January 2008. While goods and capital can move quite freely cross GCC countries, a lot of work is needed to eliminate the entrenched rigidities in GCC labor markets. The finance and economy leaders should work removing obstacles facing the path to monetary union.

While UAE’s decision to withdraw was largely motivated by political considerations, should UAE decides to opt out from the union, the authorities can make a firm decision by conducting a counterfactual analysis, judging what would happen under alternative states of the economy. A natural question to ask in this context is whether output in the UAE would be higher and prices lower if the UAE joins the monetary union. Such type of conditional analysis would help to assess the costs and benefits of not joining the union in economic terms.

If properly implemented, a GCC monetary union can prove to be very useful for the six member countries. Even though monetary policy independence would be lost as a result of the union, however, this is not a big deal for the Gulf countries as they are used to the imported monetary policies from the United States. Most importantly, under a monetary union the sovereignty of the fiscal policy is not affected. Given that fiscal policy works as the key driver of economic growth in the GCC region, forming a monetary union is expected to yield more benefits than costs. Once again, the success of a monetary union depends on fulfilling many preconditions; fortunately the Euro serves as an excellent model in dealing with various challenges that the GCC countries face.

— The author is a research economist at Qatar Central Bank. Views are author’s own.

6 Responses to "GCC monetary union: What criteria should we use to determine the location of the common central bank?"

Ivo Cerckel May 27, 2009 at 9:39 pm

The criterion to determine the location of the GCC Central Bank is the independence of the local central bank (since the outbreak of what is again being called a financial crisis, as always resulting from irredeemable, at least unbacked, paper money and from fractional-reserve banking).As Khaled Rashid al-Khater, Director of the Research and Monetary Policy Department at the Qatar Central Bank, said a month ago:Among the other central banks in Gulf states, Qatar’s central bank has been proved to be the most independent as it is the only bank which adopted a policy independent of the US Federal Reserves since the eruption of the global turmoil.Qatar to host Gulf Central BankPosted by Ivo Cerckel on May 5th, 2009http://bphouse.com/honest_money/2009/05/05/doha-to-host-gulf-central-bank/

Ivo Cerckel May 28, 2009 at 4:56 am

The geopolitics of OPEC Monetary UnionAntitrust, Israel, Iraq and IranOil pricing in Khaleeji, anyone?The Khaleeji is the proposed Gulf Co-operation Council single currency.The UAE is not seeking to rejoin the planned regional monetary union, senior government officials said on Tuesday, even as Saudi Arabia’s King Abdullah told a newspaper that Gulf countries would “review” their plans and try to resolve their differences before putting the union into effect, said the Khaleej Times yesterday.The Saudi Arabian Central bank rejects the idea of ending the dollar peg of the Saudi riyal to the US dollar saying the peg serves the Kingdom well, says the Saudi Gazette this morning.The United Arab Emirates Central Bank is saying that the UAE will continue its expansionary monetary policy without change, and will continue to peg the UAE dirham to the US dollar, says Gulf News this morning.OPEC, the Organisation of Oil Producing Countries, is meeting today Thursday in Vienna.Saudi Arabia’s oil minister, Ali al Naimi, says that the global economy has strengthened enough to cope with oil at $80 a barrel. The price rise is a function of optimism that better things are coming in the future,” Mr Naimi said, adding that customers were already demanding more oil from the kingdom. Saudi Arabia has so far refused to pump more, says the Financial Times this morning.“There is no need to cut production,” Mr Naimi said. “Making another cut now would not help stabilise the market.”, says The National in Abu Dhabi this morning.As long as the oil and gas owners continue to invoice their wealth in dollar and not in currency with freely floating gold reserves, they are doomed to remain dollar-pegged.By the same token, the old dynamics of oil supply and oil pricing in agreement or in consultation with the dollar regime will not change.Only if Asia and Europe would for instance agree to replace the petrodollar with a currency with freely floating gold reserves, (those reserves being) marked to market on a regular basis, will the Gulf Co-operation Council be able to institute an independent monetary union based on the FreeGold-wealth concept.The oil and gas owners enjoy the so-called privilege of being allowed to act in a system which violates the immoral antitrust laws of the US of A and of the European Union.As Alan Greenspan said more than 45 years ago:http://www.polyconomics.com/ssu/ssu-980612.htmThe world of antitrust is reminiscent of Alice’s Wonderland: everything seemingly is, yet apparently isn’t, simultaneously. It is a world in which competition is lauded as the basic axiom and guiding principle, yet “too much” competition is condemned as “cutthroat.” It is a world in which actions designed to limit competition are branded as criminal when taken by businessmen, yet praised as “enlightened” when initiated by the government. It is a world in which the law is so vague that businessmen have no way of knowing whether specific actions will be declared illegal until they hear the judge’s verdict — after the fact. END OF QUOTEThe oil producers are thereby forced to confirm the US of A and the European Union with their immoral antitrust laws.If the laws are immoral, how can OPEC then be said to enjoy a privilege?At that stage, it becomes the task of Israel to organise enough division in the Middle East to maintain petrodollar dependence.This explains the occupation of Iraq and the continuous menaces from Iran.The GCC Monetary Union cannot possibly be disconnected from this geopolitical fact.And then there is the fact world public-opinion considers the Arab world as Islamo-fascists.How dare the fascists attack the dollar peg?Oil pricing in Khaleeji, anyone?If they do, we will get them with out immoral antitrust laws.Ivo Cerckel

Anonymous May 30, 2009 at 4:33 am

The decision of the UAE to withdraw from monetary union was not petty and was not just political. The process that had been agreed was hijacked, making it clear that although other GCC nations would cede economic sovereignty, they would not be permitted any influence on Saudi/SAMA decisions on behalf of GCC.The meeting in early May was not supposed to determine the site of the central bank, but only the policy committee for its creation. The premature announcement that the GCC central bank would be in Riyadh made it clear that SAMA was not going to play by the rules.Moreover, it then became clear that, unlike the ECB, the GCC central bank would not be governed by a college of regional central bankers – but by SAMA alone. The rest of the central banks were invited to provide “research” which SAMA would accept or reject at its discretion.Add to this the secrecy around SAMA reserves, SAMA policy formation, the absolute political imperative of subserviance to the US dollar, and the appeal of monetary union is significantly lessened.The decision of the UAE to reject the terms of the hijacked GCC common currency was appropriate and in the best long term interests of the UAE as the financial capital of the region.

SBasher June 3, 2009 at 6:11 am

Your points are well taken. First, the point that GCC central bank will be dominated by SAMA alone is not written anywhere in the GCC agreement. Second, SAMA can continue manage the state reserve, I don’t see how this will undermine the overall foreign exchange reserve of GCC central bank which is primarily be used for conducting monetray policy such as exchange rate intervention. But you’re right that without UAE, the GCC central bank would be too much dominated by the Saudi Arabia, which is worrisome.